It's baaack! The endless bid for oil.Oil has been rallying because of the weakness of the dollar and because of the specter of impending inflation. Or at least that is what I continue to hear. Yet in the last several sessions, the dollar has found some amazing strength, and gold, the best proxy for inflation, has come down quite a bit. So what is going on with oil? What's driving oil now? It's the endless bid. Goldman Sachs recently revised its oil targets for 2009 and 2010, raising its $52 target price for the near three months to $75. It gets worse, according to Goldman. Year-end targets for the crude barrel in 2009 were revised up to $85 and a $95 target was set for 2010. How do they come up with these figures? Goldman analysts cite increased demand. Yet there is absolutely no sign that demand is increasing, quite the contrary. Goldman argues that oil is rallying on expectations of increased demand along with similar expectations of recovering economies in the second half of '09 and into 2010. Even if this gargantuan leap of faith were true, why isn't natural gas, a perfectly wonderful and plentiful energy source, rallying as well? Why is it languishing at a mere $4s/mmBTU, while crude streaks ever higher? And how do those Goldman oil analysts even create these mythical target prices? It's so hard to gauge the strength of the endless bid. The endless bid is what I've begun to call the incessant, unrelenting and often unreasonable desire of investors to have exposure to oil. In commodity index funds, through ETFs and directly in futures markets, there is a renewed interest in having oil as a part of every investor's portfolio.
The oil market is a delicate market. Even more importantly, it is a relatively puny market. New York Mercantile Exchange crude oil futures, the most widely quoted, relied-upon price gauge for oil, have about 1.3 million contracts of open interest. The average price per barrel is about $70. Therefore, the entire notional value of crude oil traded on the Nymex is a little under $100 billion. That sounds like a lot. But not if you consider that the notional value (market capitalization) of even one oil company like Chevron ( CVX) is 40% more. The market cap for Exxon Mobil ( XOM) is 3.5 times more. Intuitively, we can expect that even a relatively little amount of new investment interest in oil futures is going to have a huge impact on the price. That's the endless bid. We saw the endless bid fuel the run-up in oil to $147 in July 2008. We saw the endless bid withdraw just as quickly in late 2008 and through February of 2009 with a resultant low of $32 a barrel. And now, it's baaack ... and makes any estimate of a target price for oil a total shot in the dark, a complete guess, practically unrelated to any economic forecasts or supply/demand estimates. And where will it end? It's an important question we'll save for the next column.